Capital Allocation Trends At Genetec (TYO:4492) Aren't Ideal

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. However, after investigating Genetec (TYO:4492), we don't think it's current trends fit the mold of a multi-bagger.

What is Return On Capital Employed (ROCE)?

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Analysts use this formula to calculate it for Genetec:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.12 = JP¥252m ÷ (JP¥2.6b - JP¥544m) (Based on the trailing twelve months to December 2020).

So, Genetec has an ROCE of 12%. That's a relatively normal return on capital, and it's around the 14% generated by the IT industry.

Check out our latest analysis for Genetec

Historical performance is a great place to start when researching a stock so above you can see the gauge for Genetec's ROCE against it's prior returns. If you're interested in investigating Genetec's past further, check out this free graph of past earnings, revenue and cash flow.

The Trend Of ROCE

When we looked at the ROCE trend at Genetec, we didn't gain much confidence. To be more specific, ROCE has fallen from 17% over the last two years. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It may take some time before the company starts to see any change in earnings from these investments.

On a related note, Genetec has decreased its current liabilities to 21% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

The Key Takeaway

Bringing it all together, while we're somewhat encouraged by Genetec's reinvestment in its own business, we're aware that returns are shrinking. Although the market must be expecting these trends to improve because the stock has gained 43% over the last year. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.

Genetec does have some risks, we noticed 3 warning signs (and 1 which can't be ignored) we think you should know about.

While Genetec isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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